Oracle, Adobe, Red Hat Show Software Leverage

In theory the software business model is an attractive one. Write a piece of software. Once released, the production cost of each new copy is new zero. Sell enough copies to cover your R&D cost and your operating overhead, and you break even. After that you (and your stockholders) get rich, since each copy costs you nothing. Compare that to hardware based technology, where there (usually) is nowhere near as much profit leverage. Oracle (ORCL) , Adobe (ADBE) and Red Hat (RHT) all showcased the strength of this model when they announced their latest quarter results. Oracle reported fiscal Q3 ending February 28, 2011 on March 23. Partly because of its acquisition of Sun, revenues were up 37% y/y to $8.76 billion and net income was up 78% to $2.12 billion. [See Oracle analyst call Q3 2011] Adobe reported fiscal Q1 ending March 4, 2011 on March 22. Revenues were up 20% y/y to $1.03 billion. Net income was up 84% to $234.6 million. [See Adobe analyst call Q1 2011] Red Hat reported fiscal Q4 ending February 28, 2011 on March 23. Revenues were up 25% y/y to $244.8 million. Net income was $33.5 million, up 43% y/y. [See Red Hat analyst call Q4 2011] Note that for all three companies, profits (net income) were up on a larger percentage basis than revenues. That is the software model: once costs are covered, incremental sales have very high profit margins. Of course, if it were that simple, everyone would start a software company. Software sales are very competitive. Each of these three companies is the market leader in its domain: Oracle with database and business intelligence; Adobe with content generation; Red Hat with enterprise-grade Linux. Fail to make sales and you can lose money, or just scrape by. Naturally hardware companies are very interested in selling more of their own software with their machines, as the higher margins help the bottom line. IBM and HP, for instance, sell software and services, not just computers. One interesting play would be the small storage company Dot Hill. It has adding storage management software to its offerings, which should have a positive effect on its margins in 2011 and beyond. [See also my Dot Hill analysis page] I don't own any of the above mentioned stocks except Dot Hill, although I have owned Red Hat in the past. There are many issues to consider before buying a software stock, including its trailing and future-looking price-to-earnings ratios. So keep diversified!

Itanium Near Death

Itanium processors, decreed Intel back in 1998, were the next big thing. The question was how to deal with the 32 bit to 64 bit data path transition, which had already been made by some high-end competitors like Sun and IBM. Itanium would be the high end, while consumers and small businesses could make due for another decade with 32 bit Intel based machines.

AMD (then Advanced Micro Devices) saw an opportunity and introduced x86 chips that could run either 32 bit or 64 bit software, or both. The idea was popular partly because it was far easier for software developers to upgrade x86 code from 32 to 64 bits than to create the new, Itanium code, which had a different instruction set.

Intel had to follow AMD's lead and introduce 64 bit, non-Itanium upgrades to its chips. In addition, the original Itaniums, introduced in 2001, were not very competitive with the IBM and Sun chips. Most businesses that wanted a 64 bit transition opted to go with the lower cost AMD or Intel chips.

Intel nevertheless continued to develop Itanium chips, with HP as their main partner. The market for them was miniscule. Software developers put little effort into Itanium. Red Hat dropped Itanium software development in 2009. Microsoft announced it would phase out Itanium in 2010.

Today Oracle announced it would no longer support Itanium. Oracle dominates enterprise business and database software stacks. At the high end, it now owns the former Sun franchise, and it also runs on the new SGI high-end computers, as well as the more everyday x86 chips from AMD and Intel.

That leaves Intel working with its original partner HP. They are both big companies, but they are drifting away from reaching critical mass with Itanium. Intel is likely to drop Itanium, which means HP will have to stick to commodity CPU chips or look for another partner, perhaps IBM.

The only significant winner I see from this inevitable death of Itanium is SGI. They once made machines based on Itanium, but their new supercomputers, the Altix UV series are popular because, while they run on standard CPUs, they are very effectively glued together by SGI technology. While SGI is a small company compared to HP and IBM, if they can catch even a modest percentage of the customers that need to replace aging Itanium-based computers, they will get a very significant boost. [note: I own SGI and AMD stock at the time this is written]

See also:

www.sgi.com
http://www.hp.com/
Intel Itanium processors
http://www.oracle.com/
http://www.amd.com/

Oracle, Databases, Verticals and Business Intelligence

Oracle (ORCL) reported on its third fiscals quarter ending February 28, 2010 last Thursday. Along with other technology companies with fiscal calendars and some guidance changes, all indications are that the quarter ending December 31, 2009 was not an anomaly for the industry. Both consumers and businesses are resuming their purchases of hardware and software. While some areas of the world are now lagging, particularly Europe, on the whole the increase in demand is broad based. The release an adoption of Microsoft Windows 7 as well as new PC CPUs from Intel and AMD is making the refresh cycle attractive for servers, desktops, and laptops. The high-end cell phone craze is just adding to the rally. With some exceptions, technology stocks are undervalued, but probably will remain in that state until more money comes out of bonds and into stocks.

I'd buy Oracle right now for myself if I had a larger portfolio and wanted another relatively large cap stock. I believe Oracle is going to continue to eat SAP's and IBM's lunch, and probably steal some of Microsoft's afternoon snack as well. Now that Sun has been swallowed by the great white whale, or shark, companies that make high-end database server hardware need to fear Oracle as well. In Thursday's analyst conference Oracle management explained that they are already tearing out the unprofitable parts of Sun, like commodity hardware, and focusing on ramping the profitable parts. Sun has impressive hardware; combining it with Oracle's databases and other enterprise software application packages is going to allow companies to get bundles of value for their most demanding applications like transaction management. The Oracle hardware system for this is called Exadata, and it may prove to be a giant killer. Coming soon is the integration of Oracles software packages in Fusion, with will have built-in, across the board Business Intelligence (BI).

Microsoft, of course, is a far more diverse company than Oracle. It has a gravy train in its Windows operating system that is still under no real threat from Linux. Its database system for businesses, SQL Server, is competitive at every level from the home office to the enterprise. But at the enterprise level, SQL Server's main advantage is ease of use and integration into the legion of Windows PCs on corporate networks. For truly big enterprises, Oracle has two major advantages apart from its database's quality. Oracle is able to target verticals, which are industry segments like oil, financial services, and biotechnology, in a way Microsoft cannot. It also has a broader and probably better set of applications that are enterprise-specific such as ERP (enterprise resource planning). Oracle does not need to compete with Microsoft Office, and Office is just not that big of an edge when an enterprise is looking at something like a transactional database to deal with Internet content provision and commerce.

See also my Oracle analyst conference summary for fiscal Q3 2010 and www.oracle.com

As I write, according to Nasdaq, Oracle stock is trading for $25.36 cents, giving it a (non-GAAP) P/E of 16.6 and a forward P/E of 13.6. Which equates to annual earnings on investment of 6% and 7.35%. Which, however well it compares to other technology stocks, is way, way better than being in bonds, which are particularly unsafe now since any increase in interest rates will cause the sale value of past-issued bonds to fall.

But do Keep Diversified!

AMD Breaks New Microprocessor Ground

AMD is feisty. Despite the brutal monopoly tactics used by rival Intel (illegal kickbacks to customers; using the cash accumulated by earlier monopoly pricing to try to drive AMD out of the market; etc.), AMD is not only still in the game, it presents a growing strategic threat to Intel and a growing opportunity for eveyone else in the computer industry.

In the third quarter of 2008 AMD made progress on four major fronts. It showed a degree of creativity and flexibility that we have not seen from Intel since the 1980s. While Intel, which "owns" about 80% of the global microprocessor market, continues to have enormous advantages, it is AMD that is leading. Even if you just bought a PC with an Intel processor, its main advances over processors from 5 years ago - combined 32 and 64 bit capability, multiple processors on a single piece of silicon, and lower energy use - were all invented at AMD and then reluctantly introduced by Intel.

You can read some of this history in articles listed at my main AMD page for investors. I'm going to focus this blog entry on recent stategic developments.

One place AMD has consistently lagged Intel is process technology, which is the technology of creating semiconductor chips with ever smaller surface features. Each new generation allows more gates and hence capacity to be fit on the same size of silicon (or you can put your old design on a smaller piece of silicon, which costs less). It is very, very costly to develop each new generation, both in terms of R&D expense and then in creating the equipment that the new fab (semiconductor factories are called fabs) needs to make the improved chips. Intel made so much money from its microprocessor technology that it was able to keep well ahead of everyone else in the industry, often having as much as a two year lead time. For makers of chips requiring less transistors, this was not a big problem, unless they competed directly with Intel for a particular product.

AMD met this challenge by doing more with less; their processor designs were significantly better than Intels from about 2000 until 2006. But if AMD could be at the same level of process technology at the same time as Intel, it would be in a better position to press its design advantage. During the last decade AMD, working with IBM, has created very sophisticated fabs in Germany, and it has narrowed Intel's lead time. But it is still 6 months to a year or more behind Intel, and Intel has the money to drive the research and investment to keep that lead or even extend it. AMD is now shipping chips using 45 nm technology, but Intel started shipping theirs at the beginning of 2008.

In the past decade many major semiconductor players have emerged that don't have their own fabs. These fabless companies, like NVIDIA and Marvell, have done very well. But the independent foundries that produce chips for them have not been able to keep up with AMD in process technology, much less Intel. You might think that independent equipment makers like Applied Materials and KLA Tencor, would focus on getting ahead of Intel, but most chip makers don't have to put but a fraction of number of gates on a chip as AMD or Intel do, so the economic incentives are not there.

AMD's new stategy is to start allowing other companies to use its foundries when they need the advantage of cutting-edge chip manufacturing. As this happens research and development costs can be spread out over a larger number chip makers. With IBM, AMD and others working together it is possible that the AMD coalition could catch up with the Intel axis in process technology over the next few years.

To accomplish this strategy AMD brought in new investors, basically the nation of Abu Dhabi. AMD is contributing its fabs and some of its intellectual property to the Foundry Company, but Abu Dhabi will be the majority owners, in return for a multi-billion dollar cash infusion. In addition to continuing to expand the AMD plants in Dresden, Germany, AMD will break ground on a new plant in New York State. At a time when most new foundries are being built in places like Malasia and China, you might wonder why New York State. Well, what some people believe is the most sophisticated chip factory in the world, one of IBM's fabs, is in New York. These factories are mainly run by robots. There is no need for a lot of low-paid laborers doing hand work.

Except for the cash infusion, we won't see the results of this strategic turn until 2010 and beyond. But there are the three other fronts I spoke of: graphics, servers, and profits.

AMD aquired NVIDIA rival ATI for about $5 billion back in 2006, just in time to see ATI lose much of its share of the graphics chip market (at about the same time re-designed Intel microprocessor chips caught up with AMD's and Intel lowered prices to make all microprocessor sales unprofitable). I want to repeat what I've said many times, I think the NVIDIA team may be the smartest guys in the tech world. Still, they are AMD rivals in graphics. Recently ATI (now an AMD division) stole a march on NVIDIA with a new line of chips and graphics cards that became very popular very quickly with game enthusiasts this summer. All NVIDIA could do was lower the prices on their own chips while they rushed back to the drawing board (okay, these guys never leave the drawing board, they sleep on the drawing board, but you know what I mean).

NVIDIA still owns the graphics card market, but in Q3 AMDs graphics division revenue jumped to $385 million from $285 million in Q2, a 55% increase in 3 months. More important, AMD/ATI has two advantages over NVIDIA that might come into play in the next 2 years and allow them to eat further into NVIDIA market dominance. AMD leads NVIDIA in process technology, precisely because NVIDIA does not have its own fabs. And AMD can integrate its processor (CPU) development with its graphics development, which NVIDIA can't. This is also a three way race because Intel has long made low-end graphics chips and is trying to upgrade that division in response to the AMD threat. All this will be very good for consumers, who are already seeing inexpensive video cards that are targetted at gamers but that can easily handle high definition video and that can be used as super computers those of us who like to crunch numbers.

In server chips, so important to the Internet world, AMD is shipping its first 45 nm Opterons. Depending on what they are used for, they can be seen as better or worse than Intel's current server chips. AMD chips use less power and are better at math and sending information to and from memory. Intel chips are better at heating your building (actually, they are quite good, having finally incorporate much of the Opteron circa 2002 design improvements). The same advantage you see in Opteron server chips will soon become available in Phenom chips for desktop computers. AMD already has great notebook computer chips, the Puma series.

And for the final strategic advance, we have: profits. While still working towards GAAP and even non-GAAP net income, in Q3 2008 AMD showed operating profits. Much of the industry was concerned that if AMD continued to lose money it would be forced into bankrupcy, and Intel would go back to its high-prices and low performance everyone came to expect in the 1999s. By lowering costs, including by making the Dresden fabs highly efficient, and raising sales, AMD would have been back in the game even without the Abu Dhabi deal.

I own AMD stock and two computers containing AMD processors. I also own stock in Marvell. In the past I owned NVIDIA stock, but do not at present.

See also www.amd.com

Rackable Systems Disappoints, Promises

Rackable Systems (RACK) reported Q2 revenues that were up 12% over Q1 ($76 million v. $68 million). There are high expectations for Rackable, so the impressive sequential increase was not enough to compensate for the poor bottom line. Even on a non-GAAP basis there was a net loss of $3.5 million, or $0.12 per share. The GAAP loss was amplified by an impairment charge of $16 million to $28 million or negative $0.95 per share. [See my Rackable (RACK) analyst conference summary for August 4, 2008 for a full report]

The impairment charge was because they are "looking at strategic options" for their RapidScale storage technology, which they acquired only a few years ago, and which was supposed to help them grow into a much larger company. Obviously they expect to sell the division for less than they acquired it for, hence the write-down.

The sequential increase in revenue was marred by a single sale where management decided to make a substantial price cut to get the business. They would not name a client or a dollar amount, but they believe this one-time transaction will lead to future profitable sales.

There are, however, reasons for optimism. Management did not lower the guidance for 2008. They expect revenues of at least $353 million, which implies that Q3 and Q4 revenues will be over $100 million each, which would be quite a jump.

They have some reasons for this optimism. In a bull market the bulls would be swarming all over these "forward looking statements." The backround is their claim, upheld by independent researchers, that their technology is far more energy efficient than that of their competitors (Sun, HP, IBM, etc.). In addition to their standard data center and Internet server farm technologies, they have a product called the ICE Cube, which is a portable server farm in a standard storage container. They have been talking about this for well over a year now, and they finally completed their first sale after Q2 ended. At least as important, IBM has decided to partner with them on the ICE Cube by supplying its own blade servers (BladeCenter); presumably IBM will do the marketing on this joint product. Raytheon is also partnered with Rackable to sell ICE Cube technology to the government; it is particularly attractive for military applications.

For their standard servers (the Eco-Logical line), they had their first sale in the energy (petroleum) vertical market. About 65% of revenues were generated with sales to their current major clients, Amazon, Yahoo, and Microsoft.

And even the RapidScale debacle has its upside. They expect to announce a new, global storage partnership soon. So they don't need RapidScale as badly as some giant computer corporation needs their server farm technology.

They even made their first sale in Japan. Rackable has had weak international sales, but is working on that problem with partners.

I own Rackable stock; I am certainly not selling it at this point. Rackable has disappointed investors over the past two years, and profitability has been elusive. If you don't own the stock you might want to wait until Q3 results are in, to see if management can make good on its promises.

As always, keep diversified.

More data:

www.rackable.com
Openicon Rackable Page

IT Outlook: IBM, Intel, Yahoo Report

Yesterday, April 17, 2007, IBM, Intel, and Yahoo reported 1st quarter results and held their analyst conferences. You can look at my summaries of the analyst conferences if you would like. See IBM, INTC, YHOO.

Mostly this blog is about revealed trends and their implications for other information technology companies, but first let's look at what was revealed about the companies themselves.

IBM did really well in Asia, but revenues were essentially flat in the United States. In total revenues were up 7% from year-earlier. IBM expects EPS growth to continue at a 10 to 12% annual rate, but that depends on getting the US back on track. Their software and business services segments did best, up 9%, with their hardware segment lagging, with 2% annual growth. Within that segment high-end servers did better than low-end servers.

Intel had revenues down 1% from a year ago and down 9% sequentially (Q1 is usually a sequentially down quarter for them). But they seem to have dodged the AMD bullet. If AMD had continued to gain market share, Intel would have seen lower revenues. Flash products are still losing money for them. Q2 to be down about the typical seasonal 4%. Some remarks about selling to systems integrators seemed in the direction of saying Intel can still play hardball despite the AMD v. Intel lawsuit on anti-competitive practices. Unit production costs of microcontrollers fell faster than average sales prices (ASPs) fell, so margins were up. Server chip ASPs took a bigger hit than desktop/notebook ASPs, probably because AMD is more competive in server chips.

Yahoo revenues were up 7% over year-earlier, and down only 2% sequentially. Considering the difference in Q4 v. Q1 advertisement, that is not too bad. But it certainly does not show any market share gain against Google (See my GOOG page). If Google gained share this last year (and it almost certainly did) it was at the expense of Microsoft. Yahoo execs characterized the online ad market as going through big transitions.

Those big transitions are the news for 2007 and 2008 against which everything else must be measured. It isn't just MySpace and YouTube. Nor just the Internet. The whole global information processing structure is going through one of those periods of rapid transformation that may create totally new winners and thrust some of yesterday's winners into the loser column.

Chip and hardware makers will benefit as ever more storage and processing power is needed. While desktop processing and storage is more than adequate at this point, servers are barely keeping up, despite dual and quad processors and virtualization technology. Sun, Rackable, Dell and others are doing their best, but don't be surprised if some relative unknowns make breakthroughs in the next few years. AMD and Intel could fly if they compete on technology instead of price (which Intel signalled it is willing to do; AMD was doing it until mid 2006 and would probably be happy to return there). Innovators like Marvel and Maxim should do well -- if they make the right innovations.

While Google looks set to remain king of the online ad roost for the short term, that does not mean a swarm of innovators aren't going to be stepping up in the ranks. Not all the money is directly in ad serving, as Akamai has proven.

Asia is set to become a world leader again. With Japan, China and India all on the upswing, the United States will be technologically challenged. This will be partly offset by globalization. Innovators will do well whether in the US or India; laggers will be crushed.

I expect chip makers in general to have a relatively good Q2 and a great Q3. Server-focussed computer makers will do better than client-focussed makers. New media companies will continue to emerge rapidly. This means that venture capitalists will have a substanial advantage: the real money is made (or lost) before the IPO is set up. But stock market investors can also do well by spotting companies that are good at buying small innovators before the markets see their true value. Yahoo and IBM are both in that class.

You can check out the list of companies I do analyst conference summaries for at www.openicon.com/confsums/listcos.html

Applied Materials on 45 nm

Intel, locked in a battle-to-the-death with AMD, recently announced it had won the 45 nm war. Within hours the same day IBM announced that Intel's accomplishments, even if real, were no big deal because IBM has the same capabilities. That is good for AMD, which is partnering with IBM.

45nm means that semiconductors are constructed on a grid with cells 45 nanometers wide. Right now the most advanced silicon actually being sold is 65 nm, which Intel started selling mid-2006 and AMD started selling in January 2007. Smaller sizes mean more gates and computing power in a given area. You can, of course, waste those extra gates with a bad design.

Applied Materials executives, in the February 13th analyst conference (see my summary), gave their perspective on the transition to 45nm. They make much of the equipment used in fabrication plants to make semiconductors. They sell that equipment to just about everyone, including AMD, Intel, and IBM. They should know a thing or two about it.

They claim to have the best process. Whatever process they have they will license to anyone who will pay for it. They have worked with both IBM and Intel on the issue.

What does this mean for investors? It probably means 45 nm won't be an issue. One company or another might get an edge, but that is unpredictable right now and won't be the main determining variable. Every time process size shrinks there is a lot of handwringing; some day further shrinking either will be prohibitively expensive or just won't work.

Winners will be those who use 45 nm most effectively and are most effective at marketing. Intel is the long-reigning champion, but looks punch drunk and ready to fall. Intel fired thousands of engineers last year while AMD was hiring.

Meanwhile consumers benefit from the intense price competition. Short term investors probably want to avoid Intel and AMD, despite historically low stock prices. Long term, any letting up in the price wars will mean big bounces for both the companies.

Applied Materials on 45 nm

Intel, locked in a battle-to-the-death with AMD, recently announced it had won the 45 nm war. Within hours the same day IBM announced that Intel's accomplishments, even if real, were no big deal because IBM has the same capabilities. That is good for AMD, which is partnering with IBM.

45nm means that semiconductors are constructed on a grid with cells 45 nanometers wide. Right now the most advanced silicon actually being sold is 65 nm, which Intel started selling mid-2006 and AMD started selling in January 2007. Smaller sizes mean more gates and computing power in a given area. You can, of course, waste those extra gates with a bad design.

Applied Materials executives, in the February 13th analyst conference (see my summary), which makes equipment that any (with billions of dollars) can buy to create a semiconductor fabrication plant, said they are well-prepared for 45nm and have done their own research.

All this says that 45nm processes are mainly a red herring. One process may be better than the other on one parameter or another, but any company wanting to move into 45 nm production will be able to license the technology.

Intel is much better at announcing that it has won battles before they have begun, and at taking out ads in publications that actually review products, than it is at putting out products designed to meet its customers needs. No wonder people continue to shift to AMD processors.